Families with low and middle incomes receive significant income support through tax breaks, notably through refundable credits such as the earned income tax credit and the child tax credit. But when it comes to building wealth, the federal tax code offers those families far less.

Wealth is important: It keeps people afloat during financial emergencies like job loss or unexpected expenses. It provides a foundation for a secure retirement. And it opens doors to upward mobility, such as a down payment on a first home or college tuition.

The main wealth-building vehicles for most people in the United States are homeownership (through building equity and, hopefully, appreciation) and retirement savings accounts. Perversely, large tax subsidies for these assets mostly benefit the those already with wealth or higher incomes. Most tax benefits for the mortgage interest deduction, state and local property tax deductions, and 401(k)s and similar retirement plans accrue to those in higher income tax brackets because the subsidies are structured as deductions and exclusions, which provide households in higher tax brackets with bigger subsidies per dollar of deduction or exclusion.

Further, lower-income households are less likely to have enough deductions to make itemizing on their tax returns worthwhile, and itemization is required to claim major homeownership tax breaks. The Tax Cuts and Jobs Act of 2017 further reduced the share of the tax units itemizing deductions to between 10 and 15 percent. Lower-income workers, particularly those in part-time or temporary employment, have less access to and are less likely to participate in employer-based retirement plans.

As a related consequence,  many low- and middle-income taxpayers simply do not participate in the regular and automatic saving vehicles through which much wealth is accumulated, such as paying off a mortgage, making regular deposits to retirement accounts, and, by limiting withdrawals, letting the earnings in retirement saving accounts compound.

A variety of changes would reduce the bias toward higher-income households by replacing existing subsidies with better-targeted incentives. Almost all these proposals favor some movement toward tax credits and away from deductions, and many use insights from behavioral economics to get more bang for a tax buck forgone.

Homeownership

Credits to encourage homeownership can take different forms. They can provide an up-front credit for first-time homebuyers of primary residences, similar to the temporary credit employed as a stimulus measure from 2008 to 2009. (An early version of this credit served as an interest-free loan to be paid back to the Internal Revenue Service.) Alternatively, homeowners could receive smaller annual credits proportional to their home equity, up to a designated maximum. Another approach is to provide a credit against property taxes to defray a significant cost of homeownership. Or they could be allowed to claim a mortgage interest credit instead of a deduction. A downside of a credit is that, similar to the mortgage interest deduction it could encourage homeowners to take on more debt when they acquire a home than they otherwise would.

Retirement

A saver’s credit is available to moderate-income taxpayers who contribute to qualified retirement plans. However, the credit is nonrefundable and phases out quickly at higher incomes, making few people eligible for the maximum amount. Some economists have proposed expanding the credit and making it refundable, so that workers with no net income tax liability could claim it.

More expansive proposals include reshaping the complicated pension landscape to simplify plans and increase access to employer-based retirement accounts with automatic enrollment and automatic escalation of rates of deposit as wages increase Maximum contribution limits to tax-favored accounts can also be lowered, with the government devoting the revenue saving to beef up a match on low- and moderate-income workers’ contributions. To further promote saving, any credits or matching employer contributions could not be accessed until retirement. Pension antidiscrimination rules could be revised to favor plans that provide greater support for part-time employees.

Savings and Account Ownership

Many low- and middle-income workers receive large refunds from refundable earned income and child tax credits. A “saver’s bonus” could encourage taxpayers to save a portion of those refunds in qualified savings accounts. Taxpayers are already able to contribute to individual retirement accounts until the tax-filing deadline and apply any deductions or saver’s credits against their past tax year’s liability. Some tax preparers and tax preparation software can remind taxpayers about this choice, including how much bonus or other subsidy they would receive. Tax time could also be used to link taxpayers to savings vehicles, such as children’s savings accounts or prepaid cards with savings features for taxpayers without bank accounts.

Updated January 2024